Bonds for Every Stage of Life
Many think bonds are for the very conservative investor. But actually, bonds are an important component of a well-balanced portfolio throughout every stage of an investor’s life. They can provide stability during volatile markets, can provide an income stream, help with tax liability, and provide higher rates of return for capital growth. Regardless of your life stage, you should consider having bonds in your investment portfolio.
At the Beginning
As a beginning investor in your 20s or 30s, you have a long time to maximize capital and are probably in the best position to assume risks for larger returns. Even at this early stage of investing, you should develop a portfolio that also balances risk and market volatility. While higher-yield investments are important, you will still want to balance them with some lower-risk investments, including bonds. At this stage, you can:
Grow capital with bonds that offer higher yields if you assume higher risk. Although higher-risk bond investments have potential for loss because of interest rate and credit risk, they are typically still a safer investment than equities. Make sure you understand the terms and conditions, including the bond’s rating, call features, and if it is insured.
Protect your savings for a large purchase, such as a car, wedding, or house. Lower-risk bonds can be a better investment than a traditional savings account to save for large purchases. Bonds will pay a higher interest rate and offer a safe way to protect your savings. You may want to consider Treasury or corporate bonds with maturity dates that align with the time frame in which you will need the money.
Diversify your employer-sponsored retirement plan such as a 401(k). Your plan most likely offers a variety of mutual funds, and bond funds are a good way to diversify your portfolio and spread risk. The stock and bond markets do not typically move in the same direction, so bonds can stabilize and help with your overall returns.
In the Middle
Your mid-30s to late 40s should be a time of accumulating wealth and investing for retirement and other long-term goals. At this point in your life, you should rebalance your portfolio on a regular basis to ensure your allocation is keeping pace with your goals. Many experts agree that at this point, you should consider more medium-risk investments in combination with higher-risk investments. Bonds should become a larger portion of your asset allocation than when you were younger, because they offer more predictable income and continue to balance higher-risk equities. Following are some bonds to consider at this stage in your investment life:
Tax-advantaged bond investing is a good way to help offset taxes if you’re in a higher tax bracket. Municipal bonds, which are issued by state and local governments, are an attractive investment in your income earning years because they are exempt from federal income taxes. And if you live in the same state as the issuer, they are free from state and local taxes as well. In most cases, you should not include this type of investment in a tax-deferred retirement or college savings account, because you would be wasting the tax-exemption feature.
Zero-coupon bonds can be a good cost-effective investment for specific goals, such as college or retirement. They are sold at a steep discount from their face value; and when they mature, the face value will include both the principal and any accumulated interest. These bonds also work well in a tax-deferred account because the interest is taxable when it is credited to the bond but you can’t spend it until the bond matures.
Now that you’re getting closer to retirement, you will want to take fewer chances of losing a portion of your portfolio. Many experts recommend that at this point, you should begin increasing the bond portion of your portfolio to 50% or more to lower your risk. Some issues to consider when evaluating bonds for your portfolio:
Managing interest rate risk is important because when interest rates rise, bond prices fall and vice versa. One way to manage this risk is with a bond ladder. This strategy allows you to invest in a portfolio of bonds with different maturity time frames to help your investments do well in any interest rate environment. When rates rise, you will have short-term bonds maturing so you can then invest the principal at higher rates. And when rates fall, you will have the longer-term bonds paying higher returns.
Tax-advantaged bond investing will continue to be a good way to manage taxes, especially if you’re in a higher tax bracket. Again, municipal bonds can be a good investment choice.
Now your main goal becomes protecting and maximizing your income for the remainder of your life. Social Security will most likely only replace a portion of your income, so your portfolio and any retirement benefits will need to make up the rest. Bonds will help generate retirement income while preserving your principal. Things to consider:
Guard against inflation because you are now living on a fixed income. Treasury Inflation Protection Securities (TIPS) or Treasury Inflation Indexed Securities will help guard against inflation. TIPS have a fixed coupon rate, but their principal amount is adjusted every six months according to changes in the Consumer Price Index. When TIPS mature, you will get the higher of the original face value or the inflation-adjusted amount. You may also want to keep a small portion of your portfolio in stocks for growth potential.
Spend from taxable accounts first, because when you withdraw from tax-deferred accounts, you will pay income tax on your distributions. By spending the tax-deferred accounts last, your portfolio will continue growing tax deferred while you are in retirement.
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This newsletter was prepared by Integrated Concepts Group, Inc. The opinions expressed in this newsletter are for general information only and are not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. The views expressed are those of the author and may not necessarily reflect those held by PlanMember Securities Corporation. Material presented is believed to be from a reliable sources and PSEC makes no representation as to it accuracy or completeness.